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Southwest Reduces Its Leverage: What Does It Mean for Investors?

Ally Schmidt

Southwest Airlines' 1Q16 Results: What the Analysts Are Saying

(Continued from Prior Part)

Debt at nominal levels

The airline industry has high capital requirements due to heavy investments required in building infrastructure, as well as building and maintaining a fleet. As a result, airline stocks generally have high debt levels on their balance sheets.

Most airlines, including Southwest Airlines (LUV), have used the huge amount of cash generated in 2014 and 2015 to repay their debt. Southwest’s debt-to-EBITDA ratio fell from 1.2x at the start of 2014 to 0.7x at the start of 2015. It further fell to 0.7x at the end of 2015.

However, Southwest has gone from being net debt negative—with its cash being greater than its total debt—from the start of 2015 to net debt positive at the end of 2015. Its net-debt-to-EBITDA ratio increased from -0.2x to 0.1x at the end of 2015.

At the end of 2015, the major carriers had the following net-debt-to-EBITDA ratios:

  • Alaska Air Group (ALK): -0.4x
  • Allegiant Travel (ALGT): 0.7x
  • American Airlines (AAL): 1.9x
  • Delta Air Lines (DAL): 0.5x
  • JetBlue Airways (JBLU): 0.6x
  • Southwest Airlines (LUV): 0.1x
  • Spirit Airlines (SAVE): -0.3x
  • United Continental (UAL): 0.9x

Cash flows help reduce leverage

For fiscal 2015, Southwest Airlines (LUV) generated ~$3.2 billion in cash flow from operations (or CFO). This strong CFO has helped reduce the company’s debt and simultaneously maintain total cash on its balance sheet at $3 billion for the past five years.

Southwest Airlines has a total debt-to-equity ratio about 38.3%, which is small when compared to the regional airlines’ industry average of 149%. This is one of the reasons why Southwest is listed as one of the two investment-grade airlines. LUV forms 0.5% of the iShares Russell Mid-Cap ETF’s (IWR) holdings.

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